Commercial Bankruptcy Trends Are Concerning – Here’s an Action Plan

By David Schmidt

Bankruptcies filings have been on an upswing this year. “Elevated interest rates, rising prices due to inflation, and resumption of student loan payments are just a few examples of the economic headwinds facing businesses and individuals,” said American Bankruptcy Institute Executive Director Amy Quackenboss. “Struggling families and companies looking to find their financial footing are increasingly turning to the established path of bankruptcy.”

According to Epic Bankruptcy[1], total filings are up 17 percent for the first half of this year compared to the first half of 2022. Breaking out commercial filings, and the record is even more grim:

• So far, commercial filings have increased 18 percent in 2023 compared to the first half of last year
• Commercial Chapter 11 filings have spiked 68 percent over the same period
• Small business filings (Subchapter V elections under Chapter 11) are up 55 percent compared to the first half of last year
• Looking at just firms with more than $100 million in assets, 72 filed for bankruptcy in the first half of 2023, a 36 percent increase over the same period last year

Since mid-year, commercial filings have continued to increase. According to the American Bankruptcy Institute[2] (ABI):

• Commercial Chapter 11 filings rose 71 percent in July 2023 compared to July 2022
• Over the same period, Subchapter V small business elections accelerated 61 percent

"The increase in commercial Chapter 11 filings in July is an indication of the challenges businesses continue to face in these dynamic times; however, the data also suggests the economic recovery remains uneven and uncertain,” said Gregg Morin, Vice President of Business Development and Revenue at Epiq Bankruptcy.

And the risk continues to build up. According to CreditRiskMonitor:

• Year-to-Date (YTD) 2023 FRISK^® scored company bankruptcies (mostly public companies) increased by 65 percent relative to 2022, and have exceeded the 2020 YTD bankruptcy tally at the height of the COVID pandemic.
• YTD 2023 PAYCE^® scored company bankruptcies (private companies only) nearly doubled relative to 2022, and have also pushed above the 2020 YTD tally.
• FRISK^® and PAYCE^® score bankruptcies YTD have increased by 89 percent year-over-year, already eclipsed 2020 levels, and could be on track to exceed peak full year 2020 bankruptcies by 28 percent.

Identifying Risky Customers

What should credit managers be on the lookout for?  “Our advice for credit managers would be to very diligent with Zombie counterparties – any business with less than or equal to 1 times interest coverage ratios for the trailing twelve months (TTM) and high short-term debt/total debt – as the refinancing risk is very great.  We’d also suggest that credit managers be very mindful of public company CFOs “painting the tap” by making prompt payments while their businesses descend into financial distress,” explains Mike Flum, CEO/President of CreditRiskMonitor.

He goes on to say that the best way to see this discordance is by using a bankruptcy predictor such as CreditRiskMonitor’s FRISK® score rather than a payment behavior score like PAYDEX or Days Beyond Terms Index. The discord between financial risk and payment trends can also be seen with open-source models such as the Altman Z-Score, though not as comprehensively due to some of the Z-Score latency effects.

The team at CreditRiskMonitor also recommends some other insights that will help you identify risky customers:

• Be aware of situations where your sales teams are receiving larger orders than normal, which could be an indication that your competitors are adjusting their credit extensions lower, i.e., your company might be inadvertently taking on more risk.
• Review the customers of your customers, specifically to see if these companies are in financial trouble and/or becoming financially distressed.

When You Have a Suspect

The period before a distressed customer files for bankruptcy can be a challenging situation for credit executives. Once you have identified a suspect, here are some general recommendations to minimize the impact on your AR portfolio:

1. Cut Your Losses: If you sense a company is financially challenged or distressed, don’t extend them any additional credit. Drop their credit limit to zero so additional orders can’t slip through the system.
2. Assess the Impact: Evaluate the potential impact of a potential bankruptcy filing on your business. This includes reviewing outstanding invoices, contracts, and any ongoing business relationships with the customer.
3. Protect Your Interests: Take steps to protect your interests pre- and post-bankruptcy. This includes securing collateral if possible and exploring third-party options for recovering outstanding debts.
4. Evaluate Continuing Business: Assess whether it is in your best interest to continue doing business with the customer before and after their bankruptcy. Consider factors such as the debtor’s ability to fulfill their obligations, the potential for future payments, and the importance of the customer to your business
5. Start Negotiating Now: Begin chipping away at the balance. If they place a new order, require payment against the existing AR that is greater than the new order. If they do file bankruptcy, this allows you to employ the New Value defense should a preference issue arise with your claim.
6. Communicate Consistently and Assertively: Your recovery efforts will be more effective when you keep the lines of communication open with your clients and help you stay informed about their financial situation and potential risks.
7. Get Paid before Manufacturing or Producing any Custom Product: You don’t want to end up with useless inventory if the customer files bankruptcy.
8. Keep a Paper Trail: Documenting everything is important in case you need to make an appeal for payment or dispute a preference claim after your customer files for bankruptcy.

It is important to note that every bankruptcy case is unique, and the specific actions you should take may vary depending on your circumstances. Consulting legal professionals who specialize in bankruptcy law will provide you with tailored advice based on your specific situation.

[1] A Look Into 2023: What do the Bankruptcy Statistics Really Mean? (Epiq/JDSupra)

[2] ABI Newsroom – Bankruptcy Statistics: Monthly Trends from Epiq Bankruptcy Analytics